US in­fla­tion rears its ugly head

THE trig­ger for the next global re­ces­sion is at last com­ing into view af­ter a se­ries of loud dis­trac­tions and false alarms. The At­lanta Fed­eral Re­serve's gauge of "sticky-price" in­fla­tion in the US soared to a post-Lehman peak of 3pc in Fe­bru­ary. This in­dex is a ' pure' mea­sure of core in­fla­tion - the un­der­ly­ing story once the noise is stripped out.

The Cleve­land's Fed's ' me­dian con­sumer price in­dex' jumped to 2.9pc, with big rises are in med­i­cal ser­vices, hous­ing rents, car in­sur­ance, restau­rants, ho­tels, women's cloth­ing, jew­elry, and car hire. This is the long-feared in­flex­ion point we all for­got about in those hal­cyon days of de­fla­tion, now just a fond mem­ory. The Fed's vet­eran vice-chair­man Stan­ley Fis­cher is itch­ing to tighten. "We may well at present be see­ing the first stir­rings of an in­crease in the in­fla­tion rate," he said in a por­ten­tous speech last week.

Ev­ery ma­jor down­turn since the First World War has been caused by the Fed, de­ter­mined to snuff out in­fla­tion as the credit cy­cle ma­tures. Ex­pan­sions rarely die of old age. They are killed.

There may have been other fac­tors in each his­tor­i­cal episode - the oil shocks of the 1970s, or the first Gulf War in 1991 - but the Fed has been the de­ter­min­ing cat­a­lyst each time. Mr Fis­cher could hardly have been clearer. He spelled out why the 1970s 'Phillips Curve' trade-off be­tween un­em­ploy­ment and in­fla­tion is alive and well, and an im­plicit warn­ing that prices could soon off take since the labour mar­ket is clearly ap­proach­ing the elec­tric fence of Mil­ton Fried­man's NAIRU (non-ac­cel­er­at­ing in­fla­tion rate of un­em­ploy­ment). The econ­omy cre­ated 242,000 jobs in Fe­bru­ary. The broad U6 un­em­ploy­ment rate has dropped to a cy­cle-low of 9.7pc. The will­ing­ness of work­ers to switch jobs - the ' quit rate' - has surged since Septem­ber and is back to 2008 lev­els.

Higher wage de­mands will fol­low as surely as night fol­lows day. The Fed will not raise rates this week with so much fog still in the air. Half the world is in a sulk, the ISM man­u­fac­tur­ing gauge still below the boom-bust line of 50, and US retail sales slipped again in Fe­bru­ary. But be care­ful. John Wil­liams from the San Fran­cisco Fed says that un­der any def­i­ni­tion of the Tay­lor Rule - used by cen­tral banks to cal­i­brate pol­icy and the out­put gap - there should be an "im­me­di­ate in­crease in rates". It not hap­pen­ing yet be­cause doves first want to see the "whites of the eyes" of com­ing in­fla­tion. That is hardly a com­fort.

Mar­kets are still dis­miss­ing hawk­ish talk as blus­ter, bet­ting that the Fed will not be able to raise rates four times this year as loosely im­plied by its own ' dot plots'. Fu­tures con­tracts are pric­ing in just a 30pc chance of two rate rises. Michael Darda from MKM Part­ners said mar­kets are re­mark­ably com­pla­cent about the Fed, and warned against try­ing ex­tract much more profit from a tired rally.

"Our work­ing as­sump­tion is that we are likely in the last year to year-and-one-half of this cy­cle. On av­er­age, equity mar­kets tend to peak about six months be­fore a cy­cle peak go­ing back to 1929," he said.

Yet we are in uncharted wa­ters, and ex­actly where we stand on the mon­e­tary spec­trum is a hotly dis­puted sub­ject. "We sim­ply do not see any build-up of late-cy­cle pres­sures. We es­ti­mate that the US is about two-thirds into the cur­rent cy­cle, and have pen­cilled in the next down­turn around 2018-19," said So­ci­ete Gen­erale in a new re­port.

The oil crash has mud­died the wa­ters and dis­guised the build-up in price US pres­sures. This dis­tor­tion will dis­ap­pear by July or Au­gust. The ' base ef­fects' of oil could then start to kick in the other way, push­ing up head­line in­fla­tion as crude re­cov­ers to $50 or $60 by the end of the year - a plau­si­ble hy­poth­e­sis as out­put rolls over in Rus­sia, the North Sea, Nige­ria, Al­ge­ria, and the US shale belt.

A bizarre fea­ture of the mar­ket panic over the New Year was the widely-held be­lief that cheap oil would push the world over the edge, set­ting off mass de­faults across the en­ergy in­dus­try and a bank­ing cri­sis as CoCo bonds plum­meted. "The sto­ries we were telling each other in mar­kets in Jan­uary and Fe­bru­ary in­volved wild ex­ag­ger­a­tions and the nar­ra­tive was heav­ily in­spired by the 2008-2009 fi­nan­cial cri­sis," Torsten Slok from Deutsche Bank.